As British defined-benefit pension funds continue to reduce their active equity allocations in a multi-year de-risking push, they are now increasingly focusing on opportunities in private debt and shifting more into passive and quasi-passive equity strategies.
Both trends offer asset owners in Asia insight into the strategies being employed by their peers in one of the world's most advanced retirement industries.
All told, defined-benefit schemes in the UK have grown their use of factor-based equity assets by 17% annually from 2015 to 2017, data provided by Broadridge shows.
HSBC’s UK pension fund, for instance, has raised its quasi-passive exposure by around £4 billion ($5.2 billion) over the past couple of years, said Mark Thompson, London-based chief investment officer.
The fund invests in developed-market equities entirely through passive or quasi-passive funds, with a “climate tilt”, he told AsianInvestor. In illiquid or less homogenous markets, such as in alternative income-type strategies, it tends to go active.
Pension funds elsewhere have been upping their passive or quasi-passive exposure. The $151 billion Teacher Retirement System of Texas last year stopped using external managers to invest actively into US stocks in favour of using passive or internal quantitative strategies instead. Incidentally, it is also increasing its exposure to private debt.
Another big user of passive equity investment is London-based Coal Pensions Trustees (CPT), which manages the £21 billion ($27.5 billion) of the UK’s legacy coal industry retirement funds. It had about 45% of its total equity allocation in passive strategies as of late June, with the rest in active or factor-based investments.
PRIVATE DEBT PUSH
While DB pension funds in the UK are cutting back on active equities, they have taken the opposite view when it comes to private debt.
Pension funds from the country have been raising their exposure in recent years, in line with the global trend. Such strategies fit well with DB schemes’ desire for long-term, secure cashflows, and they can offer a yield pickup of 20 to 30 basis points over public debt.
A DB fund’s typical allocation to private debt is around 5%, up from almost zero a decade ago, noted fund executives.
The largest UK pensions have been particularly active in adding allocations and resources in this area over the past few years, said Stephen Messenger, London-based institutional sales director at Invesco.
The £9 billion British Coal Staff Superannuation Scheme, run by CPT, was targeting a 13.5% allocation to private debt as of March 31, 2017, when it had 11.1% in the asset class, up from 9.2% the year before. It also had a 4.5% allocation to special situations debt (as of March 31, 2017) and at the time was aiming to increase this to 7.5%.
These moves mirror burgeoning private debt allocations among pension funds across the world, from North America (such as Texas Teachers and Canada’s PSP Investments) to Asia (Korea’s Public Officials Benefit Association, the New Zealand Superannuation Fund and Australia’s Cbus).
To obtain this exposure, UK pensions need to look offshore, said Sorca Kelly-Scholte, head of pensions solutions and advisory for Europe, the Middle East and Africa at JP Morgan Asset Management. “The UK credit market is high quality but still pretty small and undiversified.”
The continued fallout from Brexit is another reason to consider diversifying overseas, noted Kelly-Scholte. For instance, in the UK office market, there been a rise in vacancy rates compared to elsewhere in Europe, she said.
This story is the second in a series focusing on the UK's defined benefit pension industry. For the first part, please click here. The original feature was published in AsianInvestor's June/July 2018 edition.